Taser: Stunning in Plenty of Ways

November 17, 2004

By Burt Helm Few stocks this year have moved with the volatility of Taser International (TASR). Up 650% over the last 12 months, the maker of electrically charged stun guns seems like something out of the Internet bubble: It has an astronomical price-to-earnings ratio of 90, and it moves by whole percentage numbers with little relationship to actual revenue prospects.

Case in point: On Nov. 8, the stock price rose 16% on news that the federal Transportation Security Administration had given Korean Airlines approval to use Tasers on its U.S. flights. Even though the airline already uses the weapons on its non-U.S. flights, the approval and subsequent market lift created more than $200 million in market capitalization.

LOCK ON THE MARKET. Though the stock's dramatic move on Nov. 8 may have been much more hype than actual new business, the company has real profits and strong growth potential. But because of massive day-trading action, a huge short position in the marketplace, and an already high price, it may be a stock to give wary investors pause.

There's no denying that Taser has a solid foundation, however. For the three months ended Sept. 30, the Scottsdale, Ariz., company reported earnings of $6.1 million, or 19 cents per share, up from $1.1 million, or 4 cents per share, in the year-ago quarter. It expects full-year revenue to increase 175% over the prior year.

With the X26 and the M26 models, the only stun guns on the market that pack enough power to completely immobilize their victims, Taser has next to no competition. It operates at 50% profit margins, and it has only begun to penetrate its potential markets.

Just 10% of U.S. law-enforcement officers and only 2% of all law-enforcement officers worldwide use the stun guns. Expect these numbers to change fast, however, both the company and analysts say. In the U.S., this has grown by between 1 to 2 percentage points a year. And overseas, police in Sweden and Finland as well as U.K. special-police units have received approval to use Tasers. In the coming months, Taser anticipates that police in France, Spain, and Australia will get permission to use the guns.

BIG TARGETS.Taser is also looking beyond traditional law enforcement, and sees the Defense Dept., airlines, and consumers as potential customers. All this would make the stock extremely appealing -- if it weren't already so highly priced.

Shares closed at $57.01 on Nov. 17. Not only is the p-e ratio of 90 lofty, so is the forward p-e of 60. Analysts agree that the current price and p-e ratio are reasonable only if Taser has annual revenue growth of 100% for the next three years. "That [growth] is possible," says Brian Ruttenbur, an analyst with Morgan, Keegan & Co., noting that revenues were up by 175% last year. Even though the law-enforcement market offers plenty of untapped potential, Ruttenbur says it's unrealistic to think Taser can sustain that level of growth.

Taser President Tom Smith says he sees Taser completely replacing pepper spray, which nearly every U.S. police officer now carries. However, Ruttenbur also expects market penetration to level off at 30%. The new X26 Taser costs $800, vs. about $20 for a bottle of pepper spray. Not every police department has the budget -- or the need -- for a full arsenal of such high-priced weapons.

WATCHING THE SPIKES. Smith admits they the company hasn't yet decided on guidance for 2005, because "trying to predict when a city council is going to get budget approval is next to impossible." Also, it's unclear if foreign police departments will invest fully in Tasers just because they can. The Swedish police, for instance, began using pepper spray only in the last few years.

While Taser's management may not be able to give firm guidance for next year, it has no problem keeping investors informed. The company's frequent news releases are a big reason for the stock's volatility. The short-selling position on it is huge -- roughly 16 million of the company's 19 million publicly floated shares. Says Sid Parakh, an analyst with Robins Group, "Every time there's incrementally better news...you see the guys [with short positions] scrambling in to buy the stock back." This activity creates prices spikes, Parakh says, and "the company loves doing that."

Smith says Taser just wants to keep investors up to date: "In the spirit of full disclosure, we're giving them everything so people can make rational decisions." He says that the large gains seen as a result of news releases reflect investors' renewed faith in the company.

WHAT GOES UP... Taser executives made substantial insider trades last week, selling nearly 900,000 shares in the open market, according to documents filed with the Securities & Exchange Commission. Phil Smith, Taser's chairman, says that the executives are simply diversifying their own portfolios, and that he sold a significant number of those shares due to his retirement last month.

Given that the stock can move several points on even the least substantive bit of news, imagine what will happen if and when the company has to announce growth is decelerating. "When the speculators bail on this, don't be standing in the way," says Joe Blankenship, a research analyst with Source Capital Group who has a hold rating on the stock.

Despite Taser's strong prospects, some say buying the stock at its current price likely will bring little reward. "I'm not an aggressive buyer at this point," says Blankenship, hypothetically. "I was at $40 [per share in his assessment]." Investors who buy now could be in for a serious shock later on. Helm is a reporter for BusinessWeek Online in New York